After Sternlicht, what are parents to do who want to set aside monies for children but are afraid to totally relinquish control because there could be an emergency? What are parents to do when their retirement funds go the way of Enron or Tyco and they can’t touch monies they set aside for children? Fortunately there is another way for parents to place monies into accounts for the benefit of a minor and still retain control. There is also an alternative way for parents to tax-shelter funds in an account for a minor while still retaining control.
Pursuant to the terms of federal law on qualified tuition programs, Pennsylvania adopted the Tuition Account Plan (TAP 529), which allows certain persons to save for the cost of education after high school in a tax-advantaged manner. The Pennsylvania TAP 529 accounts are qualified tuition programs that comply with Section 529 of the Internal Revenue Code of 1986 as amended. Pursuant to these federal and state acts, one opens a TAP 529 account and names a beneficiary. Unlike the PUTMA account, the TAP 529 account belongs to the account owner and not to the beneficiary. The purpose of the TAP 529 accounts is to set aside monies for the higher education of certain minors. People who can be beneficiaries of such accounts are entitled “family members,” including a son or daughter; a grandchild; a step-child; a brother, sister, step-brother or step-sister; or a spouse. The definition of “family member” is extremely broad under the federal law. The person who opens the TAP 529 account can be a grandparent; a parent; an aunt or uncle; a cousin or spouse.
A TAP 529 account differs from the PUTMA account because the person establishing the TAP account is the owner of the account and there is not an irrevocable gift to the beneficiary. The owner may withdraw monies once in every 12 months. Likewise, the owner may terminate an account. The legislation goes so far as to state that the only right of a beneficiary is if the beneficiary is also the owner of the TAP 529 account.
There are different tax consequences for withdrawing monies from a TAP 529 account, which vary with the reasons for withdrawal. If the account owner withdraws funds because of the death or permanent disability of a beneficiary or because the beneficiary had secured a scholarship, there will not be an additional 10% federal tax charged to the owner on earnings nor a 10 percent withholding penalty on earnings, which is generally due on a non-qualified distribution. If an owner withdraws monies for reasons other than those set forth in the statute, there will be adverse tax consequences. However, the key is that the owner of the account is the one who controls the purse strings.
Be Careful
A TAP 529 account owner must be very careful that he or she is not transferring PUTMA funds into a TAP 529 account. If so, I believe that the provisions of Sternlicht will control. In order to maintain control over a TAP 529 account, the account owner must open the account with funds that have not been transferred from a PUTMA account.
The provisions of the federal statute are vast. One not need be a resident of a state to open a TAP 529 account in that state. There are some states whose TAP 529 investment programs are far superior to those of others. There are certain TAP 529 accounts that are already set up for a newborn so that the growth is aggressive in the beginning and more conservative as the minor approaches college age. There are risk tolerance-based investment options such as an aggressive portfolio plan; a balanced portfolio plan; a conservative plan; and a most conservative plan. There are even socially responsible investment plans.
It is clear that families who wish more leeway in their savings plans for children will utilize TAP 529 accounts. Such accounts provide tax advantages with the account owner maintaining control. Unlike a PUTMA account where funds, once contributed, are irrevocably those of the child, TAP 529 accounts have much more flexibility. For example, once a year, the TAP 529 account owner may decide that the beneficiary of the account should be changed from one person to another. The account owner may transfer the 529 account from a Nevada to a Florida account. The account owner may terminate the account.
Therefore, in order to avoid the situation treated in Sternlicht, a parent should establish a TAP 529 account for the benefit of a minor instead of a PUTMA account. Almost every banking institution as well as various investment groups have established 529 accounts in every state in the country. A Pennsylvania parent should be aware that the TAP 529 account is a legitimate way to set aside monies for higher education for children; to secure tax advantaged savings; and yet maintain control of the purse strings.
